After hitting its two-decade high at 105, the United States dollar index (DXY), has fallen by as much as 3.20%.
Overvaluation risks grip dollar market
Twelve months of unrelenting buying preceded the U.S. Dollar’s correction over the past two weeks.
The greenback’s weight in relation to the basket of top foreign currency currencies increased by 14.3% over a year. This was primarily due to markets looking for safe havens from the fear of a hawkish Federal Reserve, and more recently the conflict between Ukraine, Russia.
DXY weekly chart. Source: TradingView
According to a Bank of America survey, global fund managers’ cash balances have increased 6.1% annually since 9/11. This was according to a Bank of America survey of 288 asset allocators. According to the report, 66% of global asset managers think that global profits will decline in 2022. This prompts them to keep “overweight” cash.
According to George Saravelos, Deutsche Bank strategist, “The market has hoarded large amounts of dollars in recent weeks,” adding that it is leading to “a very substantial dollar overvaluation.”
According to the chart below, it is possible that the U.S. Dollar’s recent retreat was an interim correction to reduce its “overbought”, conditions.
Technically, the DXY may continue to decline towards a rising trendline, which, as support, has been capped its downside moves since January 2021 as shown below.
DXY weekly chart. Source: TradingView
The index will likely pull back from the resistance range if there are more selloffs. The next downside target is the 0.786 Fib Line near 100.
Stronger euro prospects
The DXY also pulled back this week, as Christine Lagarde (president of the European Central Bank) set a new and more hawkish strategy on May 23.
Lagarde has committed to interest rate increases by September 2022. This is a departure from the ECB’s decade-long dovish monetary policies that have resulted in de facto negative rates.
The result would be that the rates in the eurozone would drop to zero. This has helped make the euro more attractive against the U.S. dollars.
Weekly price chart EUR/USD Source: TradingView
The recent IFO survey revealed that the eurozone’s confidence is still high in its ability to grow business, despite the ongoing Ukraine-Russia crises and its access of energy being hampered. This would provide a greater upside for the euro and could push the dollar lower.
IFO Survey shows strong German business confidence. Source: Bloomberg
John Authers, senior editor of Bloomberg Opinion, stated that it was still too early to predict with any certainty that the dollar will be in a declining trend.
“But its fall is another indicator that the’stagflation, ever-higher rates’ narrative is being rethought.”
EM currencies versus Bitcoin
A DXY that is weaker simply means it has a declining weight in relation to foreign currencies. A deeper examination of the dollar reveals a decline in purchasing power due to high inflation. As of April 20, 2022, the consumer price index (CPI), was at 8%.
The U.S. dollar has been stronger than it was one year ago but still not strong enough to cause emerging market currencies to fall into a tailspin and thus break their long-standing negative correlation.
Since January 2022, the returns on currencies from developing countries such as Brazil and Chile have been greater than the dollar.
Daily price chart for BRL/USD or CLP/USD. Source: TradingView
When the dollar rises, emerging market currencies (EM) tend to perform poorly. This is because investors view the greenback as their ultimate safe haven during times of uncertainty in global markets. Investors are changing their strategy as a result of the Ukraine-Russia crisis’s impact on commodity prices.
Stephen Gallo, European head for FX strategy at BMO Capital Markets, said that countries raising their interest rates are creating a favorable investment environment for their currencies.
Here are excerpts from his Wall Street Journal statement:
“Emerging market central banks are required to tighten their policy in order to keep up with the Fed. Either that or capital controls will be imposed.
Bitcoin (BTC), which is the result of the ongoing power struggle between the dollar ($USD) and the EM currencies ($EM currencies), has been left without consideration. Its value has fallen by more than 50% since November 2021, and it remains heavily associated with risk-on assets.
Related: Scott Minerd claims that Bitcoin’s price will fall to $8K but technical analysis suggests otherwise
Daily price chart for BTC/USD, showing its correlation with EUR/USD and DXY. Source: TradingView
But, Bitcoin’s negative long-standing correlation with DXY has turned to positive this week. This means that a further fall in the dollar markets may not be enough to trigger a BTC price rebound in the near future.
Cointelegraph reported recently that calls for a $20,000 macro-bottom and even lower are growing louder, as Bitcoin struggles to climb above the $30,000 mark.
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